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SABMILLER was seen as the “only world-class” South African firm 20 years ago. Since its move to London it has done its shareholders proud if you look at the growth in the firm’s value — especially in rand terms. For every year bar one from 2005, its market capitalisation has more than doubled the tangible asset base.

It tells us shareholder expectations are high because management made its strategy clear and stuck to it.

However, does profitability meet what they expect?

Market capitalisation tracks the growth in assets. As much of executive pay today is stock-based, does that also correlate to asset growth, do you think? Despite the fact that asset productivity is the fundamental driver of a firm’s longterm value, most analysts and financial journalists do seem to favour growth instead, don’t they? So, would that make it in managers’ interests to keep growing the asset base if the number and value of their share options follow?

There has been so much consolidation of brewers that opportunities to acquire more firms are few — Foster ’s is one of them. It means focus can now shift to a return on assets managed. During this seven-year period, with assets growing 140%, sales 50% and operating profit only 20%, you would expect SABMiller’s return on assets managed to droop. It has happened to all of them after the long acquisition binge.

That is not to say its asset management skills are not very good. One key measure of efficiency is the cash-to-cash cycle. This is the measure: add the number of sales days of inventory you hold to the time it takes your customers to pay you. Next, subtract from that total the number of days you take to pay your suppliers.

If you end up with a negative number, it means you generate cash from your day-to-day and month-to-month operating cycles. You’ll have cash in the bank. Except for retail firms, many companies find it difficult, even impossible, to achieve zero or a negative cash-to-cash cycle. Every year since 2005, SABMiller has achieved that or close to it. No mean feat, and it shows up in positive cash flows.

It has also reduced its material costs from 30% to about 25% of sales — a key productivity measure.

The operating people in SABMiller are way up the experience curve. They make good, low-cost beer. Their low cost-of sales creates a big gross margin sandpit for the marketing people to play in.

But how are these “brand” champions doing — the ones who seem to get all the kudos? Their “assets” are the “intangible” ones but shareholders still expect them to generate sales and profits.

They weigh heavy on the balance sheet and account for about 50% of the assets to be managed. Bring them into the return on assets managed calculation and it cuts the return down to 8%. That being the case, how good are they at marketing?

Unfortunately, in the annual report, you cannot separate beer from soft drinks. Also, there’s no split of operating assets. There used to be, but not any more.

Nevertheless, with some guessing as to the level of assets for the last couple of years, an interesting picture emerges.

Operating margins have plunged from a high of 27,3% — higher than anywhere else in SAB’s world — to a still healthy 16%. Brewing beer is good business.

In the interests of consumers — not employees — the trade unions and the government should take note. It shows what a bit of tough competition does.

Didn’t Heineken make its entrance in 2008? What effect has that had on the price of beer, do you think?

If there have been positive cost effects for us, that’s all the more reason to encourage investment and competition from outside the country. Today, we seem to want to do the opposite.

However, to get back to marketing, are the brand-building strategies as good as they make them out to be?

If they are, when can shareholders expect a better return on the “brands” management bought with a lot of their cash — all $16bn of it?

It’s now time for a steeper return-on-assets-managed curve. It does show signs of stirring. Maybe dawn has arrived at last after the long party. If they get Foster’s but quickly flog the wine assets, it could perk up even more.

Black, an affiliate of Schaffer Consulting, is an executive coach and mentor.

The world of business can learn a lot from beverage manufacturer SABMiller, a company that has been an acquisition machine in the world’s beer sector, writes Ted Black

A GOOD prophecy does not have to be right, but it should alert you. On these pages a year ago, we looked at the relationship between ROAM (return on assets managed) and market capitalisation —or value of the firm (VOF) — on the JSE.

It shows a clear, positive correlation between ROAM performance and the VOF. As ROAM rises, so does the perceived value of the sector and the companies in it. The drivers of ROAM are revenues, margins and asset productivity. They result in the three most important financial measures of operating management’s competence:

Asset productivity, or asset turnover (sales divided by assets), which give you; and

Return on assets managed (ROAM) — the total operating profitability of the business.

Managing revenue and margins are both critical tasks, but asset turnover is the most important one of the three. That is why we also took a peek at SABMiller through the asset turnover (ATO) and ROAM lenses last year.

We can learn a lot from a firm that has been an acquisition machine in the world’s beer sector.

First, what governs top management ’s behaviour? It has given up using EVA™ as a measure. It uses total shareholder return (TSR) instead. This combines share price growth and dividends over time.

However, there is a danger when you measure management with share price movements. The late Peter Drucker once said: “Stock option plans reward the executive for doing the wrong thing. Instead of asking, ‘Are we making the right decisions?’ he asks, ‘How did we close today?’ It is encouragement to loot the organisation.”

EVA™ is driven by productivity, but growth is one of the drivers of the share price and therefore TSR. That is why it makes sense for managers to go for mergers and acquisitions to accelerate growth and reward.

According to I-Net Bridge’s analysis, SABMiller directors’ remuneration in rand value has gone up 814% over a five-year period — not a bad return for their efforts.

SABMiller ’s market capitalisation has grown roughly in line with the growth of the asset base through 2004 to this year —about 190%. Exhibit 2 shows the effect of this over the past 10 years on asset productivity — a steady fall from right to left. You could call it “brewer’s droop” after SABMiller’s involvement in the consolidation “beer bust” of the past 10 years.

Mergers and acquisitions are management’s “Sun City” gamble —the big bet with high hopes that are seldom met. Statistically speaking, they seem doomed to mediocre economic performance. There is a reason for that: the sellers walk away with the value, leaving the buyer with a huge cost.

InBev is the latest example of that. It has offered $52bn for Anheuser-Busch’s asset base of $17bn —a premium of $35bn.

Accountants call it goodwill, but it does not generate a return and is bad for ROAM and the VOF. Today, Anheuser has aROAM of 17,3% on total assets. That means each year management will have to generate an additional $6bn operating profit out of the tangible assets to pay for the “opportunity cost”. It is the “winner’s curse”.

Few changes are as complex and challenging as acquisitions. The closing of the deal marks the end of a job well done. Top management celebrates victory and moves on. Making them work is someone else’s task.

That is when large numbers of people from two organisations plunge into the deep, cold waters of a new working environment. After the excitement of the courtship and consummation of the marriage, the offspring can be a big disappointment. The question becomes, how do we turn this unhappy product of a happy moment into a success? Miller is a case in point for SAB.

Despite some impressive productivity programmes described in annual reports, the acquisition seems to have put SAB management onto a permanent learning curve. You never, ever generate high productivity and cash when you learn.

Given the generally accepted 70%-80% failure rate of mergers, SABMiller ’s expansion through foreign acquisitions was seen as high risk at first. To lower the odds against it, the strategy, like all good ones, was simple and based on SABMiller’s strengths.

Its experience curve, a hugely profitable one, is anchored firmly in SA — especially Soweto. That’s not a good address by international standards. So to achieve the vision of becoming a major global player, the mission was clear and brilliantly simple: move the head office to London —a good address —and then: “Buy good beer firms at bad addresses.”

Like everything in life, it was not so simple to execute. Profitability fell steadily as the comp a ny grew in Eastern Europe, Africa, the Far East and Latin America, where it now has a big stake.

The share price languished for a while, but improved results changed capital market perceptions and doubled the VOF over a couple of years.

However, in 2002, management turned its successful formula on its head. It bought a bad beer firm at a good address — Miller in the US. In one move, it jumped onto a long, steep learning curve in a complex, highly fragmented market with a big, hostile gorilla in it.

The results since show that it cannot make the breakthrough onto a US experience curve even with highly competent operating management. The great lesson from SABMiller’s North American experience is to match opportunity with strength —not weakness.

Could that insight have prompted its decision to merge its US operation with Molson Coors and let them manage it?

The beer business is mostly a good one to be in —it has high operating margins and even the worst performers have a return on sales of about 10%. However, most of the well-known players who have been involved in the consolidation “beer bust” now have serious “hangovers ” – an intangible asset burden of around 50% of their total asset base. This causes low ATO and the effects are shown in Exhibit 2.

Low ATO companies rarely see good returns, but high margins compensate for it in the beer sector. The highest ROAM is Modelo’s 20,6% in Mexico — its return on sales is 28%. Unless you have “orderly market arrangements” as most big South African firms seem to, or you have a monopoly, low asset productivity means trouble.

Exhibit 3 shows what can happen. It looks at geographic market segments and InBev. First, compare SABMiller and Molson Coors with Anheuser- Busch’s US beer interests. It is like taking on SAB in SA.

Once the InBev deal is consummated, and $35bn is added to its asset base, Anheuser Busch will collapse in a heap in the left-hand corner along with its Chinese interests. Its ATO will be about 0,2.

That is what Bavaria’s was before SAB bought it, and why the Latin American segment also languishes down the bottom of the left-hand corner.

In last year’s article, the Molson Coors deal was being mooted. The warning given was to be wary of adding low productivity assets to low productivity assets. Rainbow Chickens tried it by acquiring Bonny Bird and Epol from Premier and took many years to recover. As Molson is already reporting poor results, will the US become SABMiller ’s Russian Front, or is this merger part of a withdrawal and regrouping strategy? In SA,Heineken ’s entry pulled SABMiller’s operating margin down to 24,3% from 27,3% and ROAM from 50% to 44%. Competition gets prices down. The very thought of it will change behaviour, which ra i s e s the final issue.

What should shareholders demand from SABMiller today? After the latest frenzy of acquisitions, they must stay sober. With rising input costs and the huge hangover of intangible assets, now is the time to focus on the VOF. The VOF is key to all management interventions. It is not growth, not revenues, not market share, not size; except to massage the VOF.

It means that productivity ratios become the only valid measures of management intent and results —not the share price. Productivity is units sold: resource units used. Improving productivity will reduce risk by influencing price recovery, which is the ratio sales price:resource price.

If you use a high selling price to make money without keeping product costs down, you increase the risk. This is price over recovery. It typically arises from sales price growing faster than resource price.

That is the basis of the information I would seek from management if I were a shareholder —or say Maria Ramos — who has just joined the board. Coupling a productivity focus to Heineken’s presence here would be good news indeed for long-suffering South African consumers. We seem to pay huge premiums for everything we buy, whether it is from the private or public sector.

Learn about “Roam” – return on assets managed – and you’ll be all the wiser, writes Gaenor Lipson.

HOW do you measure what a company is worth at present, and therefore how much a share in it should cost? In other words, how do you rate a firm’s financial health in order to get a feeling for its prospects in the future?

The authors of Who Moved My Share Price? made a name for themselves by picking holes in Dimension Data’s operating principles, and — in the minds of many people — predicting the former JSE highflier’s demise.

The book is about the importance of “Roam” — return on assets managed — in determining the value of a company.

The ratio is calculated by comparing two figures. The first is asset turnover, derived by dividing sales by assets. The second is return on sales. To get this figure, divide profit (or earnings before interest and tax) by sales, and convert it into a percentage.

More recently, Ted Black and Andy Andrews have turned their guns on SABMiller. Based on their formula, the brewer fails the test of strength.

What makes Black so sure that it is worth investors taking a long, hard look at their favourite company’s operational history?

Asset turnover is the most important measure in the equation, he says. In the case of SABMiller, “I am not saying they are going under. I am simply pointing out that their asset turnover halved from 1.6 to 0.8 before the Miller acquisition, and Roam plunged,” he says.

“This is despite a very healthy return on sales of 16%. A sharply declining asset turnover is a warning bell and SABMiller’s management had better pay attention to it — as should their shareholders.” Black is critical of SA’s top management, which he says rarely uses the Roam formula.

“Some look at assets versus earnings and others ignore the assets altogether and focus purely on earnings in isolation. This can and has led to ill-advised acquisition strategies. Meanwhile, people lower down in the organisation do the asset managing, but don’t know about Roam.”

Many managers look only at the immediate business information, such as comparisons on a quarterly basis, says Black.

“They do not look at the data trends or the history of the company, the so-called big picture. Therefore, when the company runs into problems, such as poorly thought-out strategies that lead to a decrease in the productivity of assets, management’s response is to lay off workers.”

Black says a key question to ask managers is: “What is the smallest, easiest, least expensive change we can make that gives the largest measure of sustainable improvement?” Roam, he says, allows managers to design projects that can leverage both productivity and their own personal growth.

He and a colleague, Gerard van Hoek, are teaching Roam at Sasol to everyone from senior managers to mechanics, with a focus on projects that make assets more productive. Black regards US personal computer manufacturer Dell as “getting asset management right”. He says: “It has negative working capital ... a stock turnover of 90 per year and they get paid before they pay their suppliers — just like Pick ’n Pay, another company that knows about asset turnover.”

Keep an eye on how assets perform

RETURN on assets managed is a vital measure of a company’s value, say Arjen Lugtenburg, a portfolio manager at Allan Gray, and Rodger Walters of Abvest Associates.

Walters says: “It is one of the ratios I look at in understanding what a company does and how profits are generated.”

He says companies can have a declining Roam for valid reasons, such as the start-up of a new business or division. In this situation, there could be a large outlay of capital before a profit is made.

Another good reason could be a large capital outlay for assets that will last for years, even decades — for example, the stainless steel vats that brewers use, or printing presses that can last up to 20 years if they receive proper care.

However the purchase of an existing business is not a valid reason for a decline in Roam, says Walters: “If Roam declines, it means that the new business does not have sufficient earnings, but has increased the size of the company’s assets.”

He says it is important to know what was paid for the new business and what the competition would have paid.

Lugtenburg says assets that generate relatively high returns come with a relatively higher price tag. This is because the company can grow faster with less new capital. But companies must ensure that they do not overpay, which is what happened with Dimension Data. He says the IT company did not account for its equity properly.

If it had, it would have been apparent that the asset base had enlarged without earnings increasing to the same extent.

“This fact was hidden by the issuing of new shares at a very high multiple.

“This enabled them to access capital at a very low cost.”

Roaming for the right measure

CHARTERED financial analyst Charles Hattingh is a great fan of the “return on assets managed” ratio.

Roam, he says, gives a clearer picture of a company’s health than a commonly used measure, Ebitda — earnings before interest, tax, depreciation and amortisation.

He says Ebitda is “a fad” and adds: “It is a pathetic attempt to arrive at a surrogate for cash flows attributable to the operations of the company.” Here is why:

“Earnings can and have been manipulated by management to make headline earnings a share look good.

Interest is excluded from this measure, which encourages a company to gear its operations at the expense of increasing financial risk,” says Hattingh. “It also encourages the company to capitalise operating leases, which transfers rental expenses out of operating expenses and into interest and depreciation.

Tax is — but should not be — ignored as it is part of cash flow. Accelerated tax allowances can lead to tax being expensed totally out of line with the tax paid. The end result of discounting pre-tax cash flow at a pre-tax rate can be very different to discounting posttax cash flow at a post-tax rate.

Depreciation, like tax, is a cash flow, as it includes items such as rental. Capitalise leases and suddenly cash flows increase.

“Amortisation would not be a cash flow item if a company never had to replace the asset being amortised.” Against this, Hattingh prefers Roam, which recognises tangible measures such as:

Margin (operating profit after tax but before taxed interest, divided by sales); and